IR35 scope wider under the Income Tax (Employments and Pensions) Act 2003
Article kindly provided John Antell who is a barrister specialising in commercial and employment law particularly unfair dismissal and employment status including its tax and NIC consequences. He advises contractors and others on IR35 and other employment status matters including the review or drafting of contracts, and he represents taxpayers on appeals to the General and Special Tax Commissioners and the High Court. He is the author of "Employment Status" published by Butterworths.
The latest taxation Act to be rewritten by the Tax Law Rewrite Project is the Income Tax (Employment and Pensions) Act 2003 which has received the Royal Assent and comes into effect from April 2003. The Act replaces those chapters of the Income and Corporation Taxes Act 1988 and some parts of subsequent Finance Acts, which deal with taxation under Schedule E. The guiding principle of the Tax Law Rewrite project is that taxation legislation should be progressively rewritten using a clearer style but generally without changing the law. In the case of the Income Tax (Employment and Pensions) Act 2003, however, certain changes to the law have been made including an extension to the scope of IR35 or, at least, a clarification that IR35 applies in circumstances where its application had previously been unclear from the words used in the previous tax legislation, Schedule 12 of the Finance Act 2000. The changes bring the IR35 rules for income tax closer to those which already apply for National Insurance contribution purposes.
For NI purposes IR35 applies if, broadly:
- The worker has a connection with the intermediary (such as a "one-man" company owned by the worker) through which he provides his services to a customer such that he or a person connected with him stands to receive from the intermediary money paid to it for the worker's services (in addition to any money the intermediary pays to the worker as remuneration or benefits taxed under Schedule E)?
- the circumstances in which the worker carries out work for the customer are such that if there had been a direct contract between worker and customer, the worker would have been classified as an employed earner
An "employed earner" is defined in S2(1) of the Social Security Contributions and Benefits Act 1992 as someone who is either:
- Employed under a contract of service
- The holder of an office
- deemed to be an employed earner under regulations made by the Secretary of State (such as agency workers subject to control as to the manner of rendering services)
However for Income Tax purposes, prior to April 2003, the equivalent test is not whether the worker would have been an "employed earner" but whether:
"the circumstances are such that, if the services were provided under a contract directly between the client and the worker, the worker would be regarded for income tax purposes as an employee of the client"
The expression "regarded for income tax purposes as an employee of the client" is ambiguous. On the one hand it uses the word "employee" which, in the absence of any special definition, is normally taken to mean someone employed under a contract of service. On the other hand the words "regarded for income tax purposes" presumably are intended to have some effect otherwise they would be redundant. One possible reading would be that these words mean essentially "taxed under Schedule E" thus including not only those employed under a contract of service but also office holders and agency workers subject to control as to the manner of rendering services.
The Inland Revenue (whether by concession or otherwise) have interpreted "regarded for income tax purposes as an employee of the client" in the Finance Act 2000 as meaning simply "employed under a contract of service" so that, on the Revenue's view, IR35 extended further for NI purposes than for income tax purposes. Paragraph ESM3268 of the Inland Revenue's Employment Status Manual gives the example of a worker whose services are supplied by an intermediary to a customer in the form of his being a non-executive director of the customer. As a non-executive director the worker would not have been an employee of the customer if he had contracted directly but he is an office holder. Thus, the Revenue, explain, he is subject to IR35 for NI purposes but not for income tax purposes.
In the Income Tax (Employment and Pensions) Act 2003 which takes effect from April 2003, the same words "would be regarded for income tax purposes as an employee of the client" appear. However there is a subtle difference. Whereas in the Finance Act 2000 there was no special definition of "employee", tucked away in Sections 4 and 5 of the Income Tax (Employment and Pensions) Act 2003 is a special definition of employment which specifically includes office holders. In addition s. 44 provides that agency workers subject to control as to the manner of rendering services are to be treated for income tax purposes as employees of the agency (the previous section dealing with agency workers, s. 134 of the Income and Corporation Taxes Act 1988, provided that agency workers subject to control as to the manner of rendering services were to be taxed under Schedule E but it did not in terms specify that such agency workers were to be treated, for income tax purposes, as employees of the agency, thus providing an excuse for the Revenue to refuse to allow the travel expenses of some agency workers, but that is another story). Thus, notwithstanding that the words "would be regarded for income tax purposes as an employee of the client" remain unchanged, the framework of definitions in the Income Tax (Employment and Pensions) Act 2003 has extended the scope of IR35 (or clarified the already extended scope of IR35, depending upon whether one regards the Revenue's interpretation in ESM3268 as an accurate interpretation of the law or simply a concession) for income tax purposes to include not only those who would be employed under a contract of service (if there were a direct contract between worker and customer) but also those who would be office holders of the customer or agency workers subject to control as to the manner of rendering services.
There remain a few differences between IR35 as it applies to NI on the one hand and income tax on the other. For example workers posted overseas and certain professions such as teaching can be treated differently in certain circumstances, but the Income Tax (Employment and Pensions) Act 2003 makes it clear that, at least from April 2003, the IR35 rules for income tax are now, in most cases, very similar to those which have always applied for NI purposes.
Neither the author nor the publisher can be held responsible for any actions undertaken as a result of the opinions expressed in this article which are necessarily of a general nature and cannot be a substitute for individual legal advice on your own particular situation.